When the Unthinkable Happens: IP Considerations for BankruptcyFebruary 1, 2017

In the event that the unthinkable happens and bankruptcy becomes the only course of action for businesses, having not only a good bankruptcy attorney, but also having an involved IP attorney is vital to ensure that rights in valuable intellectual property are appropriately addressed and maintained.

A basic understanding of Chapter 7 and Chapter 11 commercial bankruptcy options can help IP owners to evaluate at the outset which bankruptcy option may best protect continued IP rights.

 Chapter 7: Liquidation

Applying for Chapter 7 bankruptcy is an option for companies who make the choice to completely dissolve the business. In its most basic terms, Chapter 7 creates a bankruptcy estate that on filing owns all of the property of the business and the trustee of this estate gathers and sells the debtor’s assets and distributes the proceeds to creditors. Filing a Chapter 7 bankruptcy stays any collection actions and the sale of assets proceeds until all valuable assets of the bankruptcy estate, often including its intellectual property, are liquidated and all viable legal claims of the debtor against others are fully prosecuted. By the end, the business is an empty shell, all assets have been liquidated, and the business ceases to exist.

Chapter 11: Reorganization

In contrast, Chapter 11 has two major differences from a Chapter 7 liquidation. Unless replaced by a trustee for cause, in Chapter 11, the debtor remains in control of its reorganization process, acting with the same powers as a trustee. Additionally, to complete a Chapter 11 case, a negotiated plan of reorganization must be confirmed. At the outset, the Debtor is given a limited exclusive period to propose and confirm its plan of reorganization.  In complex cases, Chapter 11 provides for the formation of a committee of creditors selected by the Office of the United States Trustee to maintain oversight and approval of the debtor’s handling of its bankruptcy case, and this committee acts on behalf of all creditors. Discharge and a final decree are entered when the estate has been fully administered according to the plan and business can continue as normal.

At this juncture, it is important to note that the Bankruptcy code, 11 U.S.C. ยง 101 (35A), defines “intellectual property”to include trade secrets, patent (including utility, plant, and design), patent applications, plant variety, copyrights, and semiconductor chip products. Notably, trademarks and trade dress are missing for the statutory definition, but they are included in the schedule of assets required in filing under either Chapter and should be considered as property of the bankruptcy estate.

Which Chapter is Best for Me?

When considering which Chapter is most favorable, treatment of patents, trade secrets, and copyright are all nearly identical. Chapter 7 bankruptcy may be the best option when the intellectual property has value, but the business is no longer viable. In that instance, the trustee will likely transfer rights to the party providing the highest and best price and the necessary assignment documents will be required. On the other hand, Chapter 11 may be appropriate if the intellectual property is central to the business and the plan is one of reorganization rather than liquidation. Of course, with trade secrets, care should be exercised by the trustee to protect the subject matter through the necessary protective order.

Trademarks present interesting issues with regard to bankruptcy and should be carefully considered during any liquidation or reorganization filed under either Chapter. Issues of trademark abandonment may arise in situations where the business ceases to operate either before or after filing for bankruptcy. To help avoid issues of abandonment, the trustee should be advised to sell the trademark assets first to prevent any potential loss of goodwill.

Should you or your business find yourself in this situation, don’t forget to consider of the value of intellectual property. However, this is just one of many factors in determining which bankruptcy filing is most appropriate for your business and all should be carefully weighed with the advice of both your bankruptcy and intellectual property counsel.

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